Lockdown for higher savings rates

One way to get a higher return on cash is to lock up your money in a fixed-term account, for example for one, three or five years, although even these largely do not beat inflation. But after taking out the maximum in inflation-beating products such as , which we , locking up is the best low-risk strategy you have left.

The longer you hold a fixed-rate bond, the better rates you get, with the best one-year options currently offering around 3.5 per cent, and the best five-year options offering in excess of 4.6 per cent.

However, while the short-term savings bond market has remained relatively unscathed, average savings rates for long-term fixed-rate bonds have fallen significantly over recent months. The current average five-year fixed rate is 3.74 per cent - its lowest average for two years.

Louise Holmes, spokesperson for Moneyfacts.co.uk, says: "Providers appear to be funding their mortgage lending pots via the currently-low money markets, rather then through their savings products, and savers are paying the price by receiving disappointing returns on their investments."

Investment advisers suggest you proceed with caution when it comes to locking up your money. "You cannot tie up all your money as you need to have some set aside for emergencies and quick access," says Minesh Patel, managing director of independent financial adviser (IFA) EA Financial Solutions. "You should also consider having a spread of accounts with different time spans." He points out that some fixed-rate products will pay monthly interest, for example Birmingham Midshires' five-year fixed-rate Isa at 4.55 per cent. Early access to the money in some fixed-rate accounts (including this one) will incur penalties.

Another problem is interest rate risk - if you are locked in at a set interest rate you could miss out on interest rate increases. For this reason, Jason Witcomb, director at financial planner Evolve, suggests not locking up your money for more than two years. "Interest rates can only go one way from here, and that is upwards," he says.

If you do go for a longer-term fix, then you should at least ensure you are rewarded for the interest rate risk. "If you tie up your money for one year you should have an interest rate of at least 3.5 per cent, and if it is for any longer then 4 per cent or more," adds Mr Witcomb.

However, Colin Jackson, director of IFA Baronworth, argues that three years is currently the optimum term because you can get considerably higher rates than on one-year bonds, but without the long-term interest rate risk a five-year fix entails - the rate could become uncompetitive once interest rates increase. Five-year bonds also don't offer much higher interest rates than three-year ones.

Mr Patel suggests a step-up bond, such as the three-year one currently offered by Cheltenham & Gloucester. Gross annual interest on this is 3.75 per cent in the first year, 4.25 per cent in the second year and 4.75 per cent in the third year, or an annual average of 4.25 per cent. This, of course - as with all deposits held outside Isas or N&SI Savings Certificates - is before tax, so a basic-rate taxpayer actually gets 3 per cent, 3.4 per cent and 3.8 per cent.

If your spouse does not work or is taxed at a lower level than you, a good way to mitigate the tax could be to hold the account in his or her name.

Best buy three-year bonds

Source: Moneyfacts.co.uk as at 11 August 2011